The Guangzhou Sanfu New Materials Technology Co.,Ltd (SHSE:688359) share price has fared very poorly over the last month, falling by a substantial 28%. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 22% share price drop.

In spite of the heavy fall in price, when almost half of the companies in China's Chemicals industry have price-to-sales ratios (or "P/S") below 2x, you may still consider Guangzhou Sanfu New Materials TechnologyLtd as a stock not worth researching with its 9x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

How Has Guangzhou Sanfu New Materials TechnologyLtd Performed Recently?

With revenue growth that's exceedingly strong of late, Guangzhou Sanfu New Materials TechnologyLtd has been doing very well. Perhaps the market is expecting future revenue performance to outperform the wider market, which has seemingly got people interested in the stock. However, if this isn't the case, investors might get caught out paying too much for the stock.

What Are Revenue Growth Metrics Telling Us About The High P/S?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Guangzhou Sanfu New Materials TechnologyLtd's to be considered reasonable.

Taking a look back first, we see that the company grew revenue by an impressive 37% last year. The strong recent performance means it was also able to grow revenue by 75% in total over the last three years. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 26% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

With this information, we find it concerning that Guangzhou Sanfu New Materials TechnologyLtd is trading at a P/S higher than the industry. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

The Key Takeaway

Guangzhou Sanfu New Materials TechnologyLtd's shares may have suffered, but its P/S remains high. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

The fact that Guangzhou Sanfu New Materials TechnologyLtd currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. When we observe slower-than-industry revenue growth alongside a high P/S ratio, we assume there to be a significant risk of the share price decreasing, which would result in a lower P/S ratio. Unless there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Guangzhou Sanfu New Materials TechnologyLtd (at least 1 which is concerning), and understanding them should be part of your investment process.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.